It is standard practice today to offer a series of TDFs and a fund lineup of single-asset classes in the same plan. But such a structure almost guarantees that the majority of DC investors will fail to achieve optimal investment results, says Jerry Bramlett, managing partner at Redstar Advisors.
In his column in the most recent issue of NAPA Net the Magazine, Bramlett says that plan advisors should consider two hard realities about DC investors:
- Investment education programs cannot be relied upon to ensure that the majority of participants will implement risk appropriate asset allocation solutions. No one questions that the most important decision a participant makes (beyond the decision to save) is how to allocate their plan assets, Bramlett notes. But more often than not, this message does not get through to the average participant. “Just ask the average DC investor about the key to successful investing,” he suggests. “Typical responses are that it is about choosing the best performing fund, timing the market or getting good investment tips. Having a good asset allocation strategy is rarely viewed as the way in which investment return is maximized.”
- Most participants do not understand when they are actually engaged in doing their own asset allocation and when it is being done for them. The majority of target-date users are only partially invested in TDFs, Bramlett points out. “Most participants with both TDFs and single asset class funds are not there by design, but out of ignorance about when they are the asset allocator and when someone else is performing this task for them.”
The bottom line: Allowing participants to freely choose from a mix of asset allocation and single asset class funds in the same lineup is a recipe guaranteed to create confusion for all but a minority of DC investors.
However, Bramlett notes, there are ways to design an investment lineup to make it either impossible for participants to misallocate between asset classes or, at least, make it much more difficult to do so.
One simple solution, Bramlett notes, is to present a fund lineup that consists of only TDFs or managed accounts. If TDFs are offered, participants would only be allowed to invest in one fund at a time. In the case of managed accounts, by design, participants would have one option, which would be professionally managed. “Such a program would, no doubt, be viewed as overly restrictive by most plan sponsors,” Bramlett points out. But on the other hand, “This choice architecture would mostly put an end to poor (that is, nonprofessional) asset allocation decisions.”
Another, less restrictive, alternative would allow participants to invest in either a TDF or a managed account program, or to mix their own asset classes. However, they would not be allowed to pursue more than one of these investment approaches at the same time. In this structure, says Bramlett, the number of TDF users being only partially invested in TDFs (estimated recently at 62% by Financial Engines) would drop to zero. “This type of choice architecture has been adopted by a small number of larger plan sponsors that view it as the best means to ensure that there is proper asset allocation alignment at the individual participant level,” Bramlett notes.
In addition to Bramlett’s’s regular “Inside Investments” column, the summer issue of NAPA Net the Magazine includes the cover story profiling the three finalists for the 2016 NAPA 401(k) Advisor Leadership Award, as well as feature articles on the DOL’s final fiduciary rule and a wrapup of this year’s NAPA 401(k) Summit in Nashville. The issue also features insights from regular contributors Warren Cormier, Steff Chalk, Nevin Adams, David Levine, Brian Graff, Don Trone, Joseph Sam Brandwein, Fred Barstein and Lisa Greenwald.
To view Bramlett’s column, click here and select “The Plan Advisor as Choice Architect.” And to view a pdf of the full 64-page issue, click here.
